How will gold bul­lion re­act to a Fed rate hike?

The US econ­omy has been per­form­ing strongly in 2016, de­spite its ap­par­ent weak­ness in nom­i­nal terms. Com­pared to the global econ­omy, US eco­nomic growth has been sta­ble and con­sis­tent. The an­nu­alised Q1 gross do­mes­tic prod­uct growth rate of 0.5% was rather lack­lus­tre, but for an econ­omy the size and scale of the US, it was no­table given the state of the global econ­omy. Hous­ing prices in the US con­tinue to rise and the jobs mar­ket re­mains ro­bust. The do­mes­tic econ­omy is coun­tered by weak­ness in the global econ­omy.

This is be­ing fu­elled by wide­spread re­trench­ment in the oil in­dus­try and de­clines in the man­u­fac­tur­ing sec­tor. The size of the US econ­omy con­tin­ues to ex­pand, fast ap­proach­ing $17 tril­lion at con­stant prices.

The GDP per capita is also in­creas­ing in a grad­ual way. While growth re­mains tem­pered, the US econ­omy holds the man­tle as one of the world’s rich­est coun­tries, even per capita.

Mov­ing into Q2 2016, an­a­lysts are ex­pect­ing the growth of the US econ­omy to con­tinue to im­prove. GDP growth for the cur­rent quar­ter (Q2 2016) is likely to grow at 0.97%, with a quar­ter on quar­ter growth rate of 1.62%. The In­dus­trial Pro­duc­tion Re­port from the Board of Gov­er­nors and the Res­i­den­tial Hous­ing Re­port from the Cen­sus Bu­reau pre­sented an­a­lysts with pos­i­tive Eco­nomic Data. Over the next year, the Of­fice of Man­age­ment and Bud­get an­tic­i­pates that the US eco­nomic growth rate will largely re­main sta­ble, but grad­u­ally de­cline. For the re­main­der of 2016, the US econ­omy’s growth rate is likely to top that of the UK and the euro zone.

On Fri­day, May 27, gold was trad­ing at $1,212.75 per ounce, down 0.09% to $1.05. The pre­cious me­tal has en­dured sharp losses over the past 30 days, shed­ding $35.40 per ounce or 2.83%.

Gold was clos­ing in on $1,300 an ounce in May, but has lost as much as $90 dur­ing the month. The sharp losses ex­pe­ri­enced re­cently are a di­rect re­sult of the per­spec­tive shared by Fed­eral Re­serve Bank pres­i­dents and gov­er­nors and mem­bers of the FOMC. The tone in re­cent weeks has shifted from a dovish one to a hawk­ish one and this has fu­eled spec­u­la­tion that a June 14/15 pol­icy de­ci­sion will go in favour of a rate hike.

The im­por­tance of in­ter­est-rate hikes can­not be un­der­stated: The cur­rent fed­eral funds rate is 0.25% – 0.50% and a pol­icy de­ci­sion could raise that in­ter­est-rate by pos­si­bly 25-ba­sis points. One of the mea­sures used to gauge pub­lic sen­ti­ment when it comes to the like­li­hood of rate hikes is the CME Group FedWatch tool. This in­di­cates the like­li­hood of a rate hike based on con­sen­sus fore­casts. For Wed­nes­day, June 15, the im­plied prob­a­bil­ity of a 0.75% fed­eral funds rate (FFR) is 28.1%. The im­plied prob­a­bil­ity of in­ter­est rates re­main­ing at their cur­rent level of 0.25% – 0.50% is 71.9%. In April, the im­plied prob­a­bil­ity of a 0.5% in­ter­est rate was 86.9% and that of a 0.75% in­ter­est rate was 13.1%. The big jump in favour of a rate hike is an in­di­ca­tion that many more mar­ket par­tic­i­pants are jump­ing on the band­wagon of a June rate rise.

The next Fed meet­ings will take place on the fol­low­ing dates:

- July 27, with a 0.5% in­ter­est rate like­li­hood of 39.3% and a 0.75% in­ter­est rate like­li­hood of 48%;

- Septem­ber 21, with a 0.5% in­ter­est rate like­li­hood of 32.2% and a 0.75% in­ter­est rate like­li­hood of 46.4%. The re­main­ing per­cent­ages an­tic­i­pate a 1% in­ter­est rate and a 1.25% in­ter­est rate;

- Novem­ber 2, with a 0.5% in­ter­est rate like­li­hood of 29.6% and a 0.75% in­ter­est rate like­li­hood of 45.2%. A 1% in­ter­est rate is ex­pected by 21.3% of re­spon­dents and a 1.25% in­ter­est rate is ex­pected by 3.7% of re­spon­dents;

- De­cem­ber 21, with a 0.5% in­ter­est rate like­li­hood of 19.7% and a 0.75% in­ter­est rate like­li­hood of 40%. 1% in­ter­est-rate is ex­pected by 29.3% of re­spon­dents and a 1.25% in­ter­est rate is ex­pected by 9.6% of re­spon­dents.

An im­por­tant de­vel­op­ment has been tak­ing place with hedge funds of late. Prior to Janet Yellen’s speech at Har­vard Uni­ver­sity on Fri­day, May 27, hedge fund man­agers made a con­certed ef­fort to dis­in­vest from gold, an­tic­i­pat­ing the worst. May has been a par­tic­u­larly try­ing time for in­vest­ments in the pre­cious me­tal, as the like­li­hood of a Fed rate hike gath­ers mo­men­tum. The US econ­omy con­tin­ues to show signs of im­prove­ment and this does not bode well for the price of gold, or the de­mand for gold as a safe haven in­vest­ment. De­mand for gold typ­i­cally thrives when eq­ui­ties mar­kets are in trou­ble or when the US econ­omy is slip­ping.

For the year to date, gold has been per­form­ing strongly, but the mood of the mo­ment has turned against the pre­cious me­tal. When Janet Yellen gave her speech, she was un­equiv­o­cal in her com­ments to the ef­fect that a Fed rate hike in the sum­mer was im­mi­nent. Since gold is a non-in­ter­est­bear­ing com­mod­ity it can­not of­fer the same re­turns to traders and in­vestors who choose to in­vest their money in fixed-in­ter­est-bear­ing se­cu­ri­ties. As in­ter­est rates rise, so the USD rises rel­a­tive to other cur­ren­cies and this to does not bode well for the de­mand for gold. While it is not en­tirely true to say that gold has lost its lus­tre, there is clearly less of an ap­petite for the yel­low me­tal.

For the year to date, a de­cline of 26% took place in the net long po­si­tion for gold fu­tures (end­ing on May 24). Gold fu­tures dropped 2.9 per­cent­age points and closed at $1216.70 an ounce. It is the im­proved per­for­mance of the US econ­omy that is weigh­ing heav­ily on the de­mand for and the price of gold bul­lion. The in­crease in GDP dur­ing Q1 2016 was larger than an­tic­i­pated, and this up­set gold mo­men­tum. Gold reached a high in April, clos­ing in on $1300 an ounce, but has since shed much of its gains. While Janet Yellen never pro­vided an ex­act time­frame for the next se­ries of rate hikes, she did in­di­cate that it would take place within months. But 2016 has hardly been a bear­ish mar­ket for gold, with the gains for bul­lion ap­proach­ing 15% de­spite the sharp losses in May. Traders are ex­pect­ing the Fed to in­crease in­ter­est rates to 0.75% in July by a far greater mar­gin than those an­tic­i­pat­ing a rate hike in June. For now though, gold has lost favour, but may well re­cover off to profit-tak­ing drops the price and buy­ers flock back to gold once again. The pull­back in gold bul­lion is to be ex­pected given the prof­its that have been gen­er­ated.